Prime Minister Benjamin Netanyahu's decision to scrap plans for a "record" 20,000 West Bank settler homes was driven by Israel's bid to scupper an Iranian nuclear deal, observers said Wednesday.

Netanyahu publicly forced Housing Minister Uri Ariel, who had approved the plans, to back down after drawing US condemnation for a settlement project the Palestinians warned would end a fragile peace process.

Intelligence Minister Yuval Steinitz said Wednesday that all settlement plans should be "coordinated" with the premier, in cautionary remarks directed at Ariel, who himself lives in a settlement and is a member of Jewish Home, the far-right religious party in the ruling coalition.

Netanyahu had told Ariel the plan "creates an unnecessary confrontation with the international community at a time when we are making an effort to persuade elements in the international community to reach a better deal with Iran," his office quoted him as saying.

His dramatic intervention to halt the plan to build what experts said would be the biggest ever batch of settler homes on occupied Palestinian territory came after fierce criticism from the US, which has been pushing for a peace agreement between Israel and the Palestinians.

State Department spokeswoman Jennifer Psaki said Washington was not only concerned by the initial announcement of the 20,000 settler homes, but also "surprised," and sought an explanation from Israel.

She repeated the longstanding US position on settlements -- reaffirmed by US Secretary of State John Kerry during a visit to the Middle East last week -- that "we do not accept the legitimacy of continued settlement activity."

And Netanyahu directly linked his reprimand of Ariel to Israel's plans to scupper a possible international deal with Israel's arch-foe Iran over its disputed nuclear programme.

"At this time, the attention of the international community must not be diverted from the main effort -- preventing Iran from receiving an agreement that will allow it to continue its military nuclear program," Netanyahu said.

'Move undermines Iran efforts'

Science and Technology Minister Yaakov Peri said the settlement plan weakened Israel's position.

"An announcement like that... undermines not only the peace talks that are running into trouble already, but also the prime minister's efforts regarding the Iranian issue," he told public radio.

The moves came on the same day that Israel's newly reappointed Foreign Minister Avigdor Lieberman pledged to work to mend relations with the United States, which have soured over the Iran nuclear issue.

The US and Israel, along with many in the international community, accuse Iran of seeking to develop a nuclear weapon, but Tehran says its atomic ambitions are entirely peaceful.

But as the US strives towards a deal with the Islamic republic to freeze or curb parts of its nuclear programme, possibly in exchange for a relaxing harsh international economic sanctions, Israel opposes what it says would be a "bad" deal.

Israel has even threatened to strike Iran by itself if it feels military action is necessary.

Netanyahu said he spoke last week to the US, Russian, French, German and British leaders -- whose countries are among the six world powers negotiating with Iran -- and "told them that according to the information reaching Israel, the looming agreement is bad and dangerous."

On Wednesday, he urged world powers to keep up "sanction pressure" on Iran, but warned that a "bad deal" could push Israel into military action.

"There are not only two possibilities on Iran, a bad deal or a war. That's wrong," he told parliament.

"There is a third option -- and that is to continue sanction pressure. (But) I'd even say that a bad deal could bring to the undesirable second option."

A New York Times editorial described Netanyahu's opposition to an Iran deal as "hysterical," particularly his comments that such an agreement would be the "deal of the century" for Tehran.

Economy Minister Naftali Bennett travelled to the United States on Tuesday, with part of his trip focusing on meetings with senators and members of Congress over the issue.

"We will conduct a campaign in the US by meeting dozens of members of Congress, to whom I'll explain myself that Israel's security is at risk," said Bennett, the leader of Jewish Home.

Left-leaning Israeli commentators have ridiculed Israel's aggressive approach to the Iran negotiations.

"If they don't let us bomb Iran, we'll bomb the United States. That seems to be the new Israeli strategy in the face of the Iranian nuclear threat," satirised Haaretz newspaper commentator Zvi Barel on Wednesday.